We established a defined benefit plan for a new client eff. 1/1/01. As the company also started as of that date, for 2001 we were going to perform the initial valuation as of 12/31/01. As part of the proposal we developed an estimated cost for the year. The client established an account and made partial deposits during the year towards 2001.

Situation that is a little weird is that assets incurred a loss during the year. So:

Deposits $100,000 during 2001
Say credit $2,000 interest on contribution for FSA purposes.
MV of assets as of 12/31/01 was $90,000.

To establish AV of assets as of 12/31/01, I take MV Assets, subtract out contributions paid for 2001 to get IRC 404 assets. I then further subtract out interest for IRC 412 assets. Obviously I am coming up with a negative AV assets as of 12/31/01. Does this seem a little odd to anyone?

Negative assets a "little odd"? Yep.
Why aren't your assets zero for a new plan?

The reason assets are non-zero is that the client made deposits during the year. Non-zero portion represents earnings/losses that accrued on contribution deposited during year. Consider also situation where assets had gain; still would have non-zero assets.

If I just force assets for initial calculation to be zero, aren't I really forcing gain/loss from 2001 (initial year) onto 2002? Does that make sense either (remember we're talking EOY val; problem does not exist w/ BOY val).

How have others approached initial EOY val situation where funds were contributed prior to close of year?

The IRS position (at least it was 10-12 years ago when I discussed EOY valuations with Ken Black) is that the plan's first -year cost should be the same whether the val date is BOY or EOY.In other words, no g/l is recognized.Help?

My understanding is that the assets as of any val date can never consider (in any manner) actual contributions made for that plan year. I vote for zero.

Although I agree that the valuation should not consider the contributions, how do you back them out (the original dilemna)?

In a normal on-going situation, assume there have been contributions during the year. At yearend, you have a market value of assets. How do you get rid of the contributions? If you just subtract them, then any investment income/loss associated with them enter into the calculations.

That is the original setup of the problem, except that it happens to be the first year of the plan and subtracting ends up with a negative result.

The only way to end up with zero in this case is if you both subtracted the contributions and netted out any actual investment income/loss associated with those contributions. I don't know how you could calculate that in a normal ongoing situation. (And, what happens to the amounts you netted out? They are not in the contribution figure itself, so it somehow will have to show up in the second year's gain/loss.) In the first-year situation, figuring out what to net out it is pretty simple because it is whatever is left over after subtracting contributions. But, that means you are approaching a first-year situation different from later years. I don't like that answer.

I vote for using the negative market value (actual market value minus contributions).

If you have negative assets, you are recognizing an experience loss before your first valuation date. That does not make sense to me.

An alternative is to submit this question for inclusion in the Gray Book.

My dilemma is that since it is the first valuation, how do you recognize negative assets? It would seem to me that since this is an end of year valuation, then the contributions should be deemed “receivable.” I looked in the instructions for the 5500 Schedule B (how about I actually read them), and it is clearly stated in both the Current Value of the Assets and the Actuarial Value of the Assets, that “Contributions designated for 2000 should not be included in this amount.” Therefore I would go with a zero asset balance when computing any first year contributions. Any other comments or ideas?

I vote for negative assets (MV-Contrib), but I also think that you will probably be ok what ever you do. I think its purely a Year 1 problem. The beauty of DB plans is that it all comes out in the wash. By the end of the 2nd year you should be very close to the same spot regardless of which alternative you choose.

When I first read your question I thought that it sounded like a good EA-2 exam question. I agree with PAX that it would make a good "Gray Book" question. With the rise in popularity in DB plans and the down turn in the market I suggest that you submit it.

Pax,

It is too late for this year's questions in the Gray Book. The group that works with the IRS has a pre-Thanksgiving cutoff for submission. Although the questions (and suggested answers) have already been submitted to the IRS, the answers are not known yet. I think they are meeting next week to finalize the answers.

Good point about the gray book. However, I plan to go to the EA meeting. Perhaps I can remember to ask it in the IRS session.